Perhaps you’ve been a mutual fund investor and have wondered about buying individual stocks. For many people, mutual funds are all that you need. They are easy to learn, easy to invest in, and really are a “buy it and forget it” investment. Some people may wish to see if they can do just a little bit better, however, by buying individual stocks. If this sounds like you, read on.
After many years of investing in stocks, bonds, warrants, convertibles, and other assets, I’ve come to find that most of the time, buying mutual funds is preferable to buying individual stocks. It is often cheaper. It is easier. Most of the time you’ll do better just holding mutual funds. There is one strategy, however, where buying a few individual stocks, in addition to your core set of mutual funds, can pay off big, and that is to take a few concentrated positions in the “best of breed” companies, and then hold them for a long time.
Let’s break that down and discuss what it means.
Take a concentrated position: This is a trick I learned from JD Spooner’s Do You Want To Make Money Or Would You Rather Fool Around ? When you take a concentrated position, it means that you buy a lot of shares in just a few stocks – you are concentrating your money in just a few places. Many of the books you read or people you’ll hear on the radio will say that doing that is a bad idea – diversification is what you want. The issue with diversification, however, is that it dooms you to getting the market returns at best. It means that even if you’re a good stock picker, you’ll be buying the stocks you really like, plus a lot of other stocks you sort of like. If you want to beat the markets, buy large amounts of just a few companies. Just be sure you also put a good portion of your money into a set of mutual funds as well in case you turn out not to be a good stock picker.
Buy “best of breed” companies: Since you’re concentrating, this means that you have the opportunity to just buy the stocks that you’re really excited about, not your first, second, and third choices. Take advantage of this and avoid the temptation to water down your portfolio with some also-rans. Pick the best-of-the-best, buying just one or maybe two stocks in a given industry. Figure out which stock is the superstar of the group and go there. Don’t buy into McDonald’s, Taco Bell, and Wendy’s if you think Wendy’s is going to dominate the fast-food market over the next several years.
Hold for a long time: People will tell you that concentrating in stocks is risky, even if you’re buying stock mutual funds, and they would be right if you were buying for a month or even a year. The issue is that even the best of companies will have a bad quarter or a bad year, and sometimes the whole stock market has a bad year because of factors outside of the markets that worry investors. This is why you want to hold on for a long time to give the company to grow and show it’s worth without these other factors clouding your return.
Let’s look at it another way. Let’s way that you’re cousin Guido, who is a fantastic cook, is opening a spaghetti restaurant and asks you to invest. Would you invest $50,000 in the business, then expect to turn around in a year and sell out? You would know that it might take a year or two for people to find the place, or for word-of-mouth to get around how great your cousin’s marinara sauce is. There might be a recession during that year where most places – good and bad – see little traffic since most people start to eat at home. And you really want to hold on and be there when he opens a string of 50 restaurants all over the country, rather than get out with $55,000 after a year, even if that is a 10% return. If you’re going to invest in individual stocks, go for grand slams, not base hits.
If you’re interested in individual stock buying and this strategy, I go into far more detail in my book, SmallIvy Book of Investing: Book1: Investing to Grow Wealthy. Check it out at the link below if interested.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.